How To Take Advantage of a 1031 Exchange

Do you have a rental property that appreciated in value that you want to sell? You want to pull the trigger but you are afraid of the tax you will be paying on the gain. What can you do?

Millionaire investors used this strategy to build their real estate portfolio. It’s one of the most powerful tax savings strategies available to you. It’s called: 1031 exchange.

A 1031 exchange allows you to postpone your taxes by exchanging up to another higher-priced rental property. It’s a way to consolidate and build your real estate investments without paying taxes. It’s a two-step process: first step, sell your property, second step, reinvest the cash proceeds in a new property.

Here are 6 additional things you need to know about 1031 exchanges:

Must be investment property – It’s only for rental, investment or business property.

45-day rule – Replacement property must be identified within 45 days of the sale of the old property. There are no extensions allowed.

180-day rule – It must also be purchased within 180 days of the sale of the old property.

Qualified intermediary requirement – To qualify for the tax deferral, you must hire a qualified intermediary (commonly called an exchange accommodator or QI).

Cash receipt is taxable – Any cash you received or taken out during the exchange is taxable.

Consider mortgages and other debt – If you don’t receive cash back but your mortgage balance went down, that will be treated as income. For example, you had a mortgage of $500,000 on the old property, but your mortgage for the new property is only $400,000. You have a $100,000 of taxable income.

To recap, a 1031 exchange is a very powerful tool, that if you use wisely, can save you thousands of dollars come tax time. However, you have to pay strict attention to the rules of qualification. Otherwise, you could find yourself in some trouble with the IRS.

Until then, this is Noel Dalmacio, your ultimate CPA at lowermytaxnow.